Dagong Europe: Oil & Gas Industry, outlook after the end of the Super-Cycle

a cura di Dagong Europe

“The sharp oil price slide, which has brought uncertainty to both the whole industry value chain and several country economies, shouldn’t come as a surprise, given that world oil production has consistently surpassed consumption since the beginning of 2014” says Richard Miratsky, Head of the Corporates Analytical Team. “We assume that low oil prices will become a new norm and don’t expect a swift return to the USD 100-per-barrel environment. The expected 20% decrease in annual capex by the oil majors suggests that the decrease in oil prices is not a temporary dip”, concludes Mr Miratsky.

“The oil majors’ dramatically decreased revenues in 1H15 has led to an average decline of 30% in their cash flow from operations. This has directly affected their strategies, and they are now refocusing on cost rationalisation, disposal of non-core assets and substantial layoffs”, adds Marta Bevilacqua, Director of the Corporates Analytical Team. “Asset disposals among oil majors increased by 11% year-on-year during 1H15, along with intensified M&A activity: 280 deals worth USD 151Bn took place in the sector during the period. The total level of debt  among our peer group of oil majors increased by 22% year-on-year, implying a deterioration of leverage and companies’ financial strength”, concludes Ms Bevilacqua.

Main findings: 

· We don’t expect a re-bounce in oil prices in the medium term, or a return to the USD 100 per barrel environment in the foreseeable future, given the negative pressures on the oil industry. The market is now characterised by oversupply, sluggish demand and reserves at historical highs, implying lower-than-before prices. Hence, we expect the oil price to be sustained below 100 USD/bbl going forward. Futures are supporting this view: as of 12 October 2015, the oil futures expiring in December 2017 were traded at around 62 USD/Bbl.

· The change in Saudi Arabia’s policy on oil and expansion of the US shale are expected to generate further volumes for the medium term. Despite the slash in oil prices, global installed capacity is expected to slightly increase in the medium term to 103.2Mn Bbl/d against 98Mn Bbl/d recorded at YE14, or +1.04% compound average growth rate (CAGR) by 2020. Non-OPEC supply capacity, which at end-2014 amounted to 56.6Mn Bbl/d, is expected to increase by 3.4Mn Bbl/d in 5 years, to reach a capacity level of 60Mn Bbl/d by 2020, with US Light Tight Oil (LTO) or Shale Oil leading.

· Growth in fast-growing economies is slowing, posing uncertainties over oil demand. The American Energy Information Administration (EIA) estimates that global petroleum and other liquids grew by only 1.1Mn Bbl/d in 2014. The oil demand from fast-growing economies has been subdued by slowing economic growth. Growth in China, the world’s largest oil importer, is one of the main concerns for oil producers.

· Both oil-importer and exporter countries will face uncertain macroeconomic effects due to the recent oil price slump. For importing countries it will increase the real income on consumption, investments and profit. Moreover, the cost of production of final goods on average is expected to decrease, with currency expected to appreciate on average. For oil exporters the degree of a potentially negative impact is directly linked to the level of dependence of government revenues on oil exports. In many countries a sharp drop in oil prices could easily materialise into a significant fiscal deficit, accompanied by currency weakening.

· Oil companies will be obliged to make additional efforts to cope with the changed environment, continue to satisfy stakeholder interests and meet market expectations. Companies will need to dramatically readjust their cost bases to face the low-oil-price environment and maintain operating margins and decent cash flows, as the high level of debt repayments could be challenging.

· 2015 has been a record year for oil & gas industry M&A activity, with Shell acquiring British Gas for GBP 55Bn (USD 86Bn). In 1H15 the energy sector saw a total of 280 deals, amounting to a USD 151Bn, slightly below 1H14 after excluding the BG deal.

· We envisage a gloomier environment for small independent operators, oil service companies and shipyards. Since the beginning of 2015, already 15 oil companies have defaulted in the US alone and the trend is expected to increase throughout 2016. The oil service sector is suffering significantly and M&A activities are rising. Shipyards are being pinched due to cancellations and order postponements.

·  We expect the negative outlook on the oil & gas industry and its value chain to remain, at least for the next two years. Despite the counterbalancing measures that companies are putting in place, the drop in oil prices and the time-lag for demand and supply adjustments is keeping the sector from a short-term recovery.